Business and management

Law firms

The priciest partnerships

HOW DO you value a company when you cannot look at its books? That was the dilemma facing American Lawyer, which writes about the business of law firms. Undaunted, the magazine took a crack, and assigned a dollar value to 100 top firms. The results are something of a surprise.

The top-valued firms aren't the biggest by revenues (Baker McKenzie or DLA Piper), nor the most prestigious (Cravath, Swaine & Moore, say, or Wachtell, Lipton, Rosen & Katz). In fact, the number-one firm was neither a London nor a New York firm. Rather, it was Kirkland & Ellis, which is based in Chicago. The next two are Latham & Watkins and Skadden, Arps, Slate, Meagher & Flom. The full rankings can be found here, and a detailed description here.

The "value" of a company can mean different things. Market capitalisation for a public firm is simply the day's share price times the number of outstanding shares. But no top law firms are public. (Australia allows public law firms, and England has recently decided to do so as well, but none of the top firms have floated.) Book value is net assets (assets minus liabilities), or "owners' equity", in accounting terminology. But of course the private partnerships that make up American Lawyer's list don't publish numbers on audited assets and liabilities for nosy journalists to pore over.

So American Lawyer's editors had to get creative. For many years now, the big firms have sent their profit and revenue numbers to the magazine, which it uses to generate its lists of the biggest and most profitable firms. Now it took these numbers, plus a multiple generated in-house, to try to derive the value of a law firm—effectively putting itself in the shoes of a private equity firm wanting to buy one such. (This is now possible in England; it remains illegal for outside investors to buy even part of a law firm in America.)

First, AmLaw had to rejigger the firms' profit numbers. A firm's profit, after salaries for junior lawyers and staff and minus investments, is given to partners each year. But this profit includes two distinct gains for the partners: a return on their equity investments (partners buy in with their own money when made partner) and a salary for their work as lawyers. Only the first would be considered proper profit for any other kind of company (management's pay is accounted for as an expense, not part of the profit pool). So the magazine's editors split the profit 50-50, assigning half to partners as "pay" and calling the other half profit of the sort a private-equity firm would size up when researching a firm to buy.

In assigning a multiple of profits to reach a total value, American Lawyer had to make some tricky calls: how to calculate average profit, how to project it years out, how to weight revenue growth versus profit growth, and, perhaps most subjectively, how to assign a multiple based on the firm's brand. The editors gamely lay out how they did all this, admitting that it is impossible to be perfectly scientific. One twist, for example, is that London's elite "Magic Circle" firms were hurt by the weakening of the pound against the dollar in recent years.

But perhaps the biggest flaw in this calculation is that it doesn't show what any investor would demand to know when buying a firm: its liabilities. Law firms are small compared to other professional-services firms. The big audit firms, or a public consulting firm like Accenture, have staff numbering in the hundreds of thousands. The biggest law firms are in the single-digit thousands. The smaller size makes them less robust. When hard times hit, money-making partners begin to leave, revenue dries up, and more partners leave in a spiral that can quickly turn fatal. Ask anyone from Dewey & Leboeuf, a firm that ranked 38th in the AmLaw 100 in 2011 in profits per lawyer. What readers of that years' charts didn't know was the size of Dewey's debts, which quickly became unmanageable late last year, forcing the company into bankruptcy in May this year.

In other words, the newest rankings should be taken with a grain of salt; the valuations generated (Kirkland & Ellis's notional "worth" of nearly $4 billion) too. But the numbers are fun to chew over. Many lawyers blame American Lawyer, with its endless profit-rankings and lists, for helping turn an honorable profession into a grubby ordinary business. (Non-lawyers are permitted a laugh: did anyone think an elite mergers-and-acquisitions lawyer was heading to the office each day for the good of humanity?) Lawyers are competitive money-makers, and now they have one more competition to get their heart-rates up.

Readers' comments

For most of American history, lawyers were either the societal elite or were itinerant, poor nut jobs who held great admiration for law and little regard for money. There was no middle ground. Somewhere in the mid-20th century, economic incentives grew to nurture a class of well-compensated "suburban lawyers." This was paired with an explosion of regulation of large companies, creating a demand for the even-more-well-compensated Big City Lawyers who formed today's large law firms to meet the diverse needs of their enormous corporate clients. The rise of technology also meant the rise of means of mass harm, leading to the maverick plaintiff lawyer who made far more than either of the prior two groups (but was very, very rare). This, the mid-to-late 20th century was the high water mark of the well-paid, well-respected (even if simultaneously loathed) lawyer.
Now the tide is receding. A generation of bright students went to law school attracted by lawyer compensation, not the law itself, saturating the Biglaw ranks and creating a viciously competitive culture that few can survive for any length of time. This plus 30 years of stagnating and declining middle-class wages have all but eliminated the suburban lawyer. And the maverick plaintiff lawyer, while still extant, has been eroded in proportion by competition and tort reform. Meanwhile, technological change and nihilistic Baby Boomers (the first generation to go into law for the money alone) with ravaged 401(k)s shred the amount of available work. Fewer than half of today's American law graduates will ever practice law despite unprecedented loans taken out to do so. While a tiny fraction do better than ever before (see a Supreme Court clerk getting a $280,000 signing bonus), the majority are being left in the dust.
In many ways the history of American lawyers mirrors the history of America itself.

There has been no rush in the UK to purchase law firms since the market liberalised. Why not? Because lawyers have a choice who to work for, and potential purchasers are savvy enough to realise that if working for them is less attractive than working in a traditional law firm, the staff will leave and the purchase value will rapidly dissipate. And that includes holding out the possibility of something akin to partnership for those who want it. Law firm purchasers are going to have to find ways to make the working conditions better for the lawyers - including quasi-partnership prospects - as well as making the package more attractive for the customers. It's conceivable that in some areas this might work - mostly high-street consumer-focussed practice areas - but for the firms that are the subject of this blog we are no closer to tesco law than we are to tesco corporate finance or investment banking. Plus which, for businesses that are not for sale, the valuation methodology is not going to matter much. These are businesses in which the value lies in their people and the long-term investment in them, and not in arbitrary valuation rules.

It seems like a rent system the legal proffesional should open up legal services to large companies tesco offer legal services.

Just another hidden tax here in scotland the advocates society has a monopoly customers refered from lawyers.

The legal system government sponsered through legislation uncomeptiven pratices. Just like government taxing everyone more then giving lawyers a special benefit for being lawyers.

If got rid of the rules for pratices law opened up commpition, of course only a fool would pay someone that did not know and worked for self with no qualifications or repuation.
However companies like capita etc admin services or tesco could do so much with low skilled clark. Seems like law pay proffesional money basic tasks like simple wills etc.

Also unlike tradesman proffesional overcharging as can claim spend any length of time doing something no one sees so who knows.

Like the cost of government cost of law on buiness takes from other spending that be spent on produtive thing may be